The Balance-of-Payments Deficit

The overall balance-of-payments of a country, or a currency area, is in deficit when more money is paid abroad than received; a surplus occurs when more money is received by a country or currency area than paid abroad.  The United States has run an overall balance-of-payments deficit most of the past half-century and over that full period has experienced systemic inflation.  When there are substantial unemployed resources in the U.S. economy, inflation of the general price level occurs gradually; but at full employment, rapidly.

Under both the Bretton Woods agreement (1944-71) and the subsequent floating, dollar-based, reserve currency system, the U.S. budget and balance-of-payments deficits have been financed substantially by U.S. government trust funds, the Federal Reserve, and by foreign central bank purchases of dollars flooding abroad.  Since 2008 the budget and balance-of-payments deficits were accompanied by quantitative easing, a euphemism for central bank money and credit creation (or "money printing").  By this means the Fed finances not only the budget and balance-of-payments deficits, but also overleveraged banks, insolvent debtors, and other wards of the state.  But when the Fed slows quantitative easing, deflation threatens.

The balance-of-payments deficit causes Fed-created dollars to rush abroad—directed there by relative price differences.  In foreign countries, these excess dollars are monetized by foreign monetary authorities and held as official, foreign exchange reserves.  But these official dollar reserves of foreign countries are not inert.  They do not lie around in bank vaults.  They are in fact reinvested in the U.S. dollar market—especially in U.S. government securities sold to finance the federal budget deficit. In effect, the United States receives back the dollars it created to settle its balance-of-payments deficits abroad. Everything goes on as if there were no U.S. budget or balance-of-payments deficits. No adjustment is required of the United States to settle its debts, or to rebalance the deficits with surpluses.  Thus, the world dollar standard enables America to buy without really paying.  Rebalancing world trade is impossible under an official reserve currency system.  This perverse monetary system, whereby the reserve currency country issues its own money to finance and refinance its increasing deficits and debts, augments global purchasing power and potential inflation, because the newly issued money is not associated with newly produced goods and services.  Total demand has been divorced from supply.  When total demand exceeds total supply, inflation generally occurs in commodities and inflation hedges, only to be deferred in the CPI if unemployed resources exist.  Ultimately, the general price level will rise.